By Glenn Ruffenach
If you dumped any dividend-paying stocks toward the end of 2012 in anticipation of higher taxes in 2013, you might well be kicking yourself now. In a story in today’s Wall Street Journal Report on retirement planning, Charles Farrell, chief executive officer of Northstar Investment Advisors in Denver and author of “Your Money Ratios,” explains the importance of focusing on dividend growth – and the folly of trying to predict political decisions.
Dividends, of course, are a critical source of income for many retirees. As Farrell notes, corporate payouts historically account for about 50% of investors’ total returns. (The other 50% is from price appreciation or capital gains.) In other words, if you cut dividends out of your portfolio, your expected return goes from the historical average of about 9.5% to around 4.75% to 5%.
Selling dividend-paying stocks in anticipation of higher taxes could be a good example of cutting off your nose to spite your face. As we now know, dividends for most individuals – under the budget deal that emerged in Washington on New Year’s Day – will continue to be taxed at 15%. But even if rates had increased for more taxpayers, walking away from such investments would be short-sighted, Farrell argues. Rather, he says, investors should seek out companies and stocks where dividends increase steadily over time.
“With dividends, it’s the growth in payouts that fights inflation, fights taxes and helps pull along stock values,” says Farrell, who offers examples of how the math works in the Journal article.
And what of investors’ maneuverings last November and December? “Before year’s end, there seemed to be plenty of people discussing dumping dividend stocks and trying to guess which way rates were going,” Farrell notes. “If investors reacted to that, as I expect many did, then they would have most likely harmed themselves.
“It’s just a good lesson in investment and tax planning,” Farrell adds. “Don’t try to predict political decisions – which taxes are. Make the prudent investment decision and then try to manage the tax issues to the extent they impact you.”